Dirty Dozen: How to Cleanse Credit Ratings

Securities industry task force has its own ideas for improving the system — 12 of them.

A securities industry task force has published 12 recommendations for credit-rating industry reforms, targeting more disclosure of the ratings process, among other things.

The report is from the Securities Industry and Financial Markets Association’s (SIFMA) Credit Rating Agency Task Force, formed to examine key issues related to ratings and credit rating agencies. It is comprised of 37 individuals from the U.S., Europe, and Asia, and includes asset managers, underwriters, and issuers expert in structured finance, corporate debt, municipal debt, and risk.

“Investors’ ability to better understand the credit rating agency inputs and methodology will allow investors to incorporate ratings appropriately in their own internal risk assessments and investment decision analytics,” says Boyce Greer, a task force cochair and president of Fixed Income and Asset Allocation at Fidelity. “This, in turn, is a key element of strengthening the securitized credit markets.”

The group says that its recommendations are being shared with regulators, lawmakers, and credit rating agencies globally, and reflect the efforts of the senior-level investor-led industry group.

Ratings services have been under fire in recent months, and just this week the three largest were slapped with a lawsuit from the state of Connecticut, claiming there are unfair variances between the systems used to rate public bonds and corporate bonds.

In the SIFMA task force report, 16 key issues are ranked in order of importance. The group’s recommendations address those issues that topped the list, including transparency, model quality, and surveillance.

The recommendations encourage enhancing disclosure of rating methodologies, due diligence information, surveillance procedures, credit rating agency performance, and fees, as well as a more harmonized and convergent global regulatory framework, and independent risk analyses by investors.

The task force also identifies the need for industry members, globally, to provide expert input and advice on issues related to credit ratings to regulators, lawmakers, and other market participants. To this end, it recommends creation of a global, independent industry credit-ratings advisory board under the auspices of SIFMA. Board members initially would be drawn from the task force, but would continue its work to date as an advisor and consultative resource.

The recommendations say credit rating agencies (CRAs) should:
• provide enhanced, clear, concise, and standardized disclosure of CRA rating methodologies;
• disclose results of due diligence and examination of underlying asset data examinations, and limitations on available data, as well as certain other information relied upon by the CRAs in the ratings process;
• disclose CRA surveillance procedures, to foster transparency and allow market users of ratings to understand their bases and limitations;
• provide access to data regarding CRA performance; this will allow investors to assess how CRAs differ both in the performance of their initial ratings, and in their ongoing surveillance of existing ratings;
• address conflicts of interst with sensitivity toward CRA “core” services and consulting services;
• have established for them a global SIFMA advisory board to help regulators and lawmakers on ratings issues;
• be subject to coordinated work by lawmakers, regulators, and law enforcers around the world;
• disclose to regulators the CRA fee structures and identities of top payors;
• ensure that ratings performance of structured products are consistently in line with ratings performance of other asset classes, boosting investor confidence in the reliability of ratings;
• avoid using rating “modifiers” to create transparency, something that leads to unnecessary costs and could trigger negative consequences.

In addition:
• Investors should understand the limits of ratings, and consider them one of many inputs and considerations;
• All members of the financial industry involved in generation and use of ratigns should examine their processes “with an eye towards improvement, incluidng working towards standardizing reprotign and disclosure on underlying assets.”

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